In Focus - Sri Lanka’s Fiscal Forecast for 2025-2026
Note: Our fiscal forecasts were done before the impact of Cyclone Ditwah was fully apparent. In this month’s focus, we take a deep dive into our revised fiscal forecast for both 2025 and 2026 in the overall context of the economy, but we think these numbers probably shift somewhat once the impacts of the current crisis become clearer. Our view in the current context is that the topline fiscal strength is likely to not only remain largely unaffected – but also to supportive to any fiscal costs that come up across the few months for disaster relief. With the continuous revenue over-performance even alongside higher expenditures made on account of disaster relief, the primary balance seems to be well on its path to overperform both the government estimates as well as the target set by the IMF during the Extended Fund Facility (EFF) arrangement. Despite the shock, 2025 could see the 3rd consecutive primary fiscal surplus. On the other hand, with the 2026 government budget that was passed maintaining the same fiscal reforms that were held for the past 2 years with few changes, it is very likely for this positive trend to continue into the next year as well – even when fiscal costs of disaster relief and infrastructure redevelopment are considered. If economic activity remains buoyant, due to disaster related spending and reconstruction/donation efforts, revenue should be largely unaffected as well.
Continuation of fiscal overperformance would likely see record high fiscal performance by end-2025
Frontier expects government revenue for 2025 to go even beyond what we had previously estimated. While vehicle tax revenue is a big reason for this overperformance, it is definitely not the sole reason with taxes including VAT, Income Tax and Import duties all rising by a significant amount throughout the year. Despite an increase in Personal Income Tax (PIT) threshold to Rs. 150,000 per month from April of this year, whereby there was a fall in people liable to pay taxes from the lower tax bracket and some changes to the income tax bracket, direct income tax experienced a marginal pickup. This could possibly be due to better tax collection as well as increasing number of new tax registrations where in 2025 the government saw 200,000 new individual taxpayers and 18,000 new company registrations.
In terms of capital expenditure, the government has so far heavily underspent the budgeted value due to a number of reasons including procurement delays, time spent for setting up anti-corruption measures by the new government, administrative delays and low foreign loan disbursement being actualized during the year. We do see few infra-structure and construction related projects resuming especially from the second half of the year and with our expectation to see some spikes in capex during December as a result of government having to repair some of the big damages that were left as a result of the disaster situation of the cyclone.
Continued overperformance on fiscal revenue and under-budgeted expenditure to continue into 2026.
While Sri Lanka saw revenue collected from PAYE tax and income tax increase considerably during 2025, we may see some continuous growth in 2026 albeit not as dramatic as 2025. This increase would simply be due to more people now being included in the tax bracket as a result of income growth and more employers now being in a position where they can formalize their business operations and register as tax paying firms.
Consequently, in terms of recurrent expenditure, we see some significant gap in what was budget and what would actualize especially on components such as Salaries and Wages as well as in interest payments and subsidies and transfers. While the government expects to carry out the second phase of the public worker salary increments from January of 2026, we feel the allocated Rs. 110 Bn may be an over-estimation and may be based on the cost of approved number of employees of the public sector in the beginning of 2025, which seems to be much higher than the actual mid-year workforce due to a large number of pensioners through the year.
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